Understanding Cash Credit and Overdraft Facilities
Cash Credit (CC) and Overdraft (OD) are revolving credit facilities designed to meet the working capital needs of businesses. These facilities provide businesses with access to funds up to a pre-sanctioned limit, with interest charged only on the amount actually utilized.
For manufacturing and trading businesses, managing inventory and receivables requires flexible funding solutions. CC and OD facilities bridge the gap between cash outflows (for purchasing inventory) and cash inflows (from sales collections), ensuring smooth business operations.
Key Differences: CC vs OD
Cash Credit (CC)
- • Secured against stock and book debts
- • Monthly stock statements mandatory
- • Drawing Power based on stock/debtors
- • Ideal for manufacturing/trading
Overdraft (OD)
- • Can be secured or clean (unsecured)
- • No monthly statements required
- • Fixed limit or against securities
- • Suitable for service businesses
Cash Credit in Detail
Cash Credit is a secured working capital facility where the bank provides funds against the hypothecation of current assets—primarily inventory (stock) and receivables (book debts). The borrowing limit is determined based on the value of these current assets, subject to margin requirements.
How Cash Credit Works
Bank sanctions a limit based on working capital requirement
Borrower submits monthly stock statements showing inventory and debtors
Bank calculates Drawing Power based on eligible assets less margin
Borrower can withdraw funds up to the Drawing Power
Interest charged daily on outstanding balance, debited monthly
Overdraft Facilities
Overdraft allows account holders to withdraw more than their available balance up to a pre-approved limit. Unlike CC, OD doesn't require monthly stock statements and offers more flexibility in usage.
Types of Overdraft
Secured Overdraft
Against fixed deposits, shares, bonds, property, or other securities. Lower interest rates due to collateral security.
Clean Overdraft
Based on creditworthiness and banking relationship. Higher interest rates, typically for established customers with good track record.
Stock Statements Explained
Monthly stock statements are the lifeblood of cash credit accounts. They inform the bank about the current levels of inventory and receivables, which determines how much the borrower can draw.
Contents of Stock Statement
- Opening Stock: Value at beginning of month
- Purchases: Goods bought during the month
- Sales: Goods sold during the month
- Closing Stock: Value at month end (raw material, WIP, finished goods)
- Book Debts: Outstanding receivables with age-wise breakup
- Creditors: Amounts payable to suppliers
Submission Timeline
Typically due by 7th-10th of the following month. Delayed submission attracts penal interest (typically 2% over normal rate) and may restrict further drawings.
Drawing Power Calculation
Drawing Power (DP) is the maximum amount a borrower can withdraw from their CC/OD account. It's calculated by applying margins to eligible current assets.
DP Calculation Example
| Stock Value | ₹10,00,000 |
| Less: Creditors | ₹3,00,000 |
| Net Owned Stock | ₹7,00,000 |
| Margin @ 25% | ₹1,75,000 |
| DP from Stock | ₹5,25,000 |
| Book Debts (Eligible) | ₹7,00,000 |
| Margin @ 40% | ₹2,80,000 |
| DP from Debtors | ₹4,20,000 |
| Total Drawing Power | ₹9,45,000 |
Standard Margins
- Raw Materials: 20-25%
- Finished Goods: 25-33%
- Book Debts (< 90 days): 40-50%
- Book Debts (> 90 days): Ineligible
Interest Calculation
Interest on CC/OD is calculated using the daily reducing balance method. This means interest is charged only on the actual amount utilized and only for the number of days it remains outstanding.
Interest Formula
Interest = (Outstanding Balance × Rate × Number of Days) ÷ 365
Example Calculation
For a 30-day month with varying balances at 12% p.a.:
- Days 1-10: ₹5,00,000 → Interest = ₹1,644
- Days 11-20: ₹7,00,000 → Interest = ₹2,301
- Days 21-30: ₹4,00,000 → Interest = ₹1,315
- Total Monthly Interest: ₹5,260
Managing CC/OD Effectively
Best Practices
Submit Stock Statements on Time
Delays can restrict your drawing power and attract penal interest. Set calendar reminders for submission.
Monitor Drawing Power vs Outstanding
Regularly check that your outstanding doesn't exceed DP. Excess drawals attract penal interest and may be reported as irregular.
Maintain Adequate Security Cover
Ensure your stock and debtors value comfortably covers your borrowing. Low coverage may lead to limit reduction.
Plan for Renewals
Start renewal process 60 days before expiry. Delays can disrupt your working capital availability.
Warning Signs to Watch
- • Consistently utilizing 90%+ of limit (indicates under-sanction)
- • Frequent excess over DP (indicates poor inventory management)
- • Increasing debtor days (indicates collection issues)
- • Stock audit objections (indicates record-keeping problems)
Conclusion
Cash Credit and Overdraft facilities are essential tools for managing business working capital. When used effectively, they provide the liquidity needed to seize business opportunities and manage operational cycles smoothly.
Success with these facilities requires discipline in stock management, timely documentation, and proactive communication with your banker. Understanding how Drawing Power works and monitoring your utilization pattern helps avoid costly penalties and maintains a healthy banking relationship.
Remember: CC/OD is meant for working capital cycles, not long-term funding needs. Use it wisely to support inventory and receivables, and ensure timely repayment to maintain a strong credit profile.